Let us begin by trying to summarise the long Brexit saga. The UK is currently run by a Prime Minister (PM) who does not command a majority in Parliament, nor has the backing of the British people (hence his desire for general elections) but wants to implement Brexit at all costs. The Parliament, which the PM tried to sideline, is back in function – thanks to the Supreme Court’s ruling that the 5-week suspension was unlawful – and has voted that the PM need ask the European Union (EU) for another extension of the Brexit deadline if no agreement has been ratified in the meantime. This involves renewed negotiations with the EU, of which little actually seems to be taking place, and the resolution of the single biggest issue: the Irish border.
To understand why this issue is so important, just picture the route taken by goods travelling into the EU. Following Brexit, the border between the Republic of Ireland (to remain an EU member) and Northern Ireland (part of the UK) will be the only land crossing between the EU and the UK. If no custom controls are put in place along this border, goods that do not meet the EU’s strict standards would be able to use Northern Ireland as a “back door” into the EU. Given the region’s fraught history, reinstating such checkpoints could, however, endanger the 20-year old truce, as well as weigh on economic growth on each side of the border.
The solution negotiated by ex-PM Theresa May, known as the “backstop”, involved the UK remaining part of Europe’s customs union – unpalatable to the hardline Brexiters, in part because it ruled out a bilateral trade agreement with the US (whose standards, notably on food and cars, are considerably lower than those of the EU). It is said Boris Johnson is now proposing that only Northern Ireland stay binded to the EU, effectively moving the EU/UK border into the Irish sea. But that would involve goods being checked at the ports connecting Northern Ireland to mainland UK – an outcome that the Northern Ireland Democratic Unionist Party (which has 10 votes in the UK Parliament) has always rejected.
At this point, no one knows how the situation will evolve – other than the fact that odds of reaching a new and acceptable Brexit agreement, in the space of just one month, are very low. So then, no-deal Brexit or further extension of the deadline? While the former may be favoured by some EU country leaders – and can be imposed by the EU (by refusing another deadline extension) regardless of the UK Parliament’s position – it would pose a risk to the European economy at large, at a time where the German engine is already faltering.
What looks certain is that monetary policy will remain ultra-accommodative. Indeed, the European Central Bank (ECB) went all-in at its mid-September meeting, pushing interest rates further into negative territory and restarting bond purchases. A few days later, the Federal Reserve followed suit, with its second 25 bp rate cut this year. For investors, persistently low/negative rates mean little other option but to turn to risky assets. Floored by the central bank “put”, they at least offer the possibility of a positive return, relative to a foreseeable loss of capital in the fixed income space. So, although recognising the worrisome economic picture, we continue to favour (asset-backed and decently valued) equities over bonds – while holding on to gold as insurance.
Germany Headed Towards Recession?
At first, the difficulties of the German car makers were viewed as temporary – related to the stricter emission standards for new passenger cars and light vehicles adopted last April by the EU Parliament and Council (in the wake of the diesel scandal). With these regulations to apply from 2021 onwards, and a phase-in starting already next January, it was to be expected that potential new car buyers delay their purchases.
Now, however, it is looking like some are maybe rethinking the very idea of getting a new car. With standards becoming ever more stringent and cities starting to restrict access – all for very good reason – why invest in a vehicle that might be obsolete or “useless” within a couple of years? Incidentally, ship owners are faced with the same dilemma, ahead of IMO regulation aiming at drastically lower carbon emissions. Despite the record high freight rates currently enjoyed by the shipping industry, new build orders remain exceptionally low.
Returning to Germany, to the extent that car industry woes are more than just temporary, the slowdown looks set to continue – and even extend to other segments of the economy. For the first time in many years, Europe’s engine is faltering, with obvious risks for its many trade partners across the continent. Not surprisingly, this has led to suggestions – including some very clear rhetoric by the outgoing ECB President – that the time has come for fiscal stimulus measures. Unfortunately, the EU countries that have budgetary leeway do not appear to want to go down that route, while those keen to implement government spending programs do not have the financial means to do so.
In a scenario whereby Germany decides to maintain a rigorous attitude on spending and Brexit is of the hard version, Europe would need to brace itself against recession – just as the EU and ECB governing instances undergo a transition.
But even if Germany, despite its wariness of repeating the errors of the 1930s, were to decide to go ahead and stimulate its domestic economy via (justified) investments in infrastructure, alongside some Nordic countries, all of Europe’s problems would not be solved. Headline GDP growth for the region might be sustained, but the divide between the North and South would only get larger.
President Trump and the US-China Trade War
A final word on the Trump factor – which does continue to move financial markets. The recently launched impeachment process certainly has a high hurdle to overcome, requiring some 20 Republican senators to turn against “their” president, but it cannot be completely dismissed. Wait and see…
Meanwhile, we see no progress on the trade front and worry that chances of a solution to the US-China conflict are fading. Negotiations do not really seem to have resumed, and President Trump continues to raise the stakes. His latest move was to sanction Chinese shipping company Cosco, one of the largest in the world, for having transported Iranian oil. Its tanker branch has been blacklisted, effectively removing 5% of the global fleet. Going forward, no charterer will want to put cargo on Cosco’s vessels, because one cannot be sure whether a given ship has actually carried Iranian oil – or if the US will just suspect it of having done so – in which case it will not be allowed to cross the US border. Not to mention that the dollar can no longer be used as a currency for trades that fall under the realm of US sanctions.